Thematic Research Sector Report: Shedding light on new industry challenges Executive Summary June 2015
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Executive Summary Shedding light on new industry challenges Analysts Silvana van Schaik Associate Analyst, Research Products Silvana.vanschaik@sustainalytics.com Doug Morrow Associate Director, Thematic Research Doug.morrow@sustainalytics.com Sophia Burress Analyst, Research Products Sophia.buress@sustainalytics.com Dr. Hendrik Garz Managing Director, Thematic Research Hendrik.garz@sustainalytics.com Sector Leaders 1 Top ten companies Country Score Allianz SE Germany 84.9 Storebrand ASA Norway 84.2 Swiss Re Ltd Switzerland 84.2 Munich Re Ag Germany 82.1 Achmea BV Netherlands 82.0 CNP Assurances SA France 82.0 Aviva plc United Kingdom 81.8 AXA Group France 81.2 Delta Lloyd N.V. Netherlands 80.7 Sanlam Limited South Africa 77.4 Key Takeaways Industry Trends Regulators are raising the bar for capital requirements. While the ostensible intent is to minimise the industry s insolvency risk, many insurers find themselves highly exposed to tightening regulations. According to Europe s pension regulator, one in 12 European insurers is not prepared to comply with the Solvency II Directive, which is scheduled to take effect on 1 January 2016. Low interest rates are putting pressure on insurer s profits and could threaten the ability of some insurers to fulfill their policy obligations in as little as eight years, according to recent industry data. The industry is struggling to respond to rising consumer demand for technology-enabled insurance products. First movers are using online platforms and social media to refresh their product offerings. Big data offers insurers almost limitless possibilities for premium price optimisation, yet concerns about data privacy are rising, and recent breaches of data security have been widely condemned by consumers and industry groups. A growing number of insurers are experimenting with wearables and vehicle monitoring devices. These technologies could precipitate a shift from a pooled risk approach to more individualised and granular assessments. By 2050, 21% of the world s population is forecasted to be 60 or older (up from 12% today). The global demographic transition will offer new product development opportunities for insurers, but penalties for being on the wrong side of the longevity risk curve could be severe. ESG Performance Looking at the industry through an ESG lens, we find meaningful differentials in company performance on the key issues of Responsible Finance, Financial Product Governance and Business Ethics. The marginal financial materiality of these issues is increasing as the market s expectations regarding product development, data security and ethical performance continue to rise. Taking special account of the industry s exposure to climate change, we find large discrepancies in insurers strategies to manage climate-driven risks and niche opportunities, including catastrophe bonds. Our top industry performers are Allianz, Storebrand and Swiss Re. These companies have implemented best-in-class ESG policies and programmes and demonstrate a high degree of risk awareness. We judge these companies to be comparatively well positioned to deliver shareholder value going forward. 3 P a g e
Juggling with change The industry is set to face several daunting challenges in the months ahead. The dual headwinds of tightening capital requirements and a likely continuation of the low interest rate environment are likely to provide a formidable test for many insurers. For U.S. insurance companies, the Fed s promise to raise its benchmark federal funds rate is signalling an easing of margin pressure. But in Europe, insurers profits are being squeezed by the European Central Bank s (ECB) quantitative easing (QE) programme, which has exacerbated the slide on bond yields. Insurers are facing increased pressure to get their longevity models right Big data has been seized upon as a way to optimise premium pricing The myriad risks of technology Top ESG performers are well positioned to compete Supplementing these challenges are the impacts of global demographic transition. The world s population is ageing, due to the effects of global industrialisation and advances in medical technology. While insurers are likely to benefit from increased demand for post-retirement products, pressure is rising for insurers to get their longevity models right, particularly for those with a large annuities business. For many insurers, salvation is seen in technology. Digital technologies, including online distribution platforms and social media, offer tremendous promise for insurers to personalise products, connect with younger customers and improve claims management. And big data has been seized upon as a way to optimise premium pricing, with some insurers beginning to tap real-time information from vehicle monitoring devices and, to a lesser extent, wearable technologies. Yet the risks associated with these technologies can hardly be overstated. Big data may fundamentally change the way insurance companies think about and measure risk, as they move away from pooled risk categories to far more nuanced and individualised risk assessments. Technology is also blurring the lines between industries and creating new competitors for incumbent insurers. Large Internet companies, such as Google and Amazon, are already making tentative inroads into the industry, as they seek new channels to capitalise on their brand equity. And other technologies, such as driverless cars, could have truly disruptive effects for certain industry segments. In this rapidly evolving environment, looking at industry players through an ESG lens can offer a differentiated take on company analysis and positioning. While advanced ESG programmes and policies are not a panacea for all of the challenges facing the industry, we believe top ESG performers are well positioned broadly to compete in a business environment where product innovation, expanded risk awareness and stakeholder management are seen as increasingly important drivers of value. This view dovetails with a growing body of research that finds a positive relationship between performance on material ESG issues and stock returns. Identifying material ESG issues In this report, we focus on the three key ESG issues that we believe are of fundamental importance for investors: Responsible Finance; Financial Product Governance; and Business Ethics. As shown in the matrix below, these issues are distinguished by their large sustainability and business impacts and their potential to generate material risks and opportunities for industry investors. 4 P a g e
Materiality Matrix Business Ethics Responsible Finance Data Privacy and Security Financial Product Governance Physical Impacts of Climate Change Human Capital Key ESG issue Other relevant ESG issues Source: Sustainalytics Responsible Finance Big opportunity, lack of action Baseline: weak Outlook: positive Baseline: moderate Outlook: neutral Responsible Finance in the industry involves integrating ESG factors into asset management and underwriting activities and developing sustainable insurance products. While many insurers have proven to be adept innovators on these fronts, the industry as a whole has been slow to capture associated market opportunities. Still, our outlook for the industry is positive, as recent developments could pave the way for rapid product and service deployment. Financial Product Governance Recovering from a reputational low point Financial Product Governance looks at the industry s approach to customer relations, with a focus on illicit pricing strategies and claim refusals. The industry s performance in these areas is generally improving, as evidenced by the declining number of related lawsuits in key markets. However, the industry still trails other sectors in overall positioning on Financial Product Governance. Still, we expect to see continued movement by insurers on this issue in the year ahead. Business Ethics Driving customer trust Baseline: moderate Outlook: positive Business Ethics in the industry translates into companies involvement in illegal business practices, including money laundering and tax evasion. Failing to manage Business Ethics can have dramatic downside impacts on a company s reputation, with possible knock-on effects on financial performance. A growing number of insurance companies are infusing corporate decision-making processes with risk management provisions governing these issues, although violations persist. We are cautiously optimistic about the industry s direction on this issue. 5 P a g e
Key ESG Issues Leaders & Laggards Overview Responsible Finance Financial Product Governance Business Ethics Developed Markets Emerging Markets Leaders Laggards Leaders Laggards Storebrand ASA Swiss Life Holding AG Sanlam Limited White Mountains Group, Ltd. Munich Re Ag Suncorp Group Limited Cathay Financial Holding Co. Ltd. Axis Capital Holdings Ltd. CNP Assurances SA Migdal and Financial Holdings Ltd. Sul America Sa Everest Re Group Ltd. Achmea BV Fairfax Financial Holdings Limited Santam Ltd. Arch Capital Group Ltd. Swiss Re Ltd Loews Corporation Samsung Fire & Marine Co., Ltd. PartnerRe Ltd. Storebrand ASA ACE Limited Sanlam Limited Powszechny Zaklad Ubezpieczen Spolka Akcyjna Delta Lloyd N.V. AEGON N.V. Santam Ltd. New China Life Co., Ltd. Old Mutual plc AIA Group Limited Sul America Sa Axis Capital Holdings Ltd. Legal & General Group Plc Progressive Corp. Liberty Holdings Ltd. Hanwha Life Co., Ltd. Hannover Rueck SE Baloise-Holding Hyundai Marine & Fire Samsung Life Co. Ltd. Storebrand ASA American International Group, Inc. Dongbu Co., Ltd. Discovery Holdings Limited Munich Re Ag Admiral Group plc RenaissanceRe Holdings Ltd. Shinkong Financial Holding Co. Ltd. AEGON N.V. AIA Group Limited PartnerRe Ltd. New China Life Co., Ltd. Prudential Financial, Inc. Migdal and Financial Holdings Ltd. Sul America Sa MMI Holdings Limited Sun Life Financial Inc. Willis Group Holdings Public Limited Company Porto Seguro SA China Pacific (Group) Co., Ltd. Source: Sustainalytics Industry leaders (DM & EM) 1 Top five companies (DM) Country Score Allianz SE Germany 84.9 Storebrand ASA Norway 84.2 Swiss Re Ltd Switzerland 84.2 Munich Re Ag Germany 82.1 Achmea BV Netherlands 82.0 Top five companies (EM) Country Score Sanlam Limited South Africa 77.4 Santam Ltd. South Africa 67.6 Sul America Sa Brazil 66.6 Liberty Holdings Ltd. South Africa 66.4 Samsung Fire & Marine South Korea 66.3 Qualitative Performance 1 Operations - Env. Supply Chain - Env. Products & Services - Env. Employees Supply Chain - Social Customers Society & Community Business Ethics Corporate Governance Public Policy Size breakdown 1 # of companies 100 50 0 10 20 30 40 50 60 # of companies Category 1 Category 2 Category 3 Category 4 Category 5 Overall score Maximum: 85 Average: 65 Median: 67 Minimum: 45 0 31-40 41-50 51-60 61-70 71-80 81-90 91-100 Overall score Overall Upper MCap bracket (>USD 7.2bn) Lower MCap bracket (<USD 7.2bn) Selective results of our bottom-up analysis Leaders: Within developed markets, our top performers are Allianz, the German multiinsurer; Storebrand, the Norwegian life insurance firm; and Swiss Re, the world s second-largest reinsurer. The five highest-scoring insurers are all based in Europe, illustrating the region s comparatively advanced insurance practices. In emerging markets, South African firms took three of the top five spots, with Sanlam and Santam leading the pack. Momentum: The ESG performance for the industry has improved marginally in recent years, with the mean universe score increasing from 52.6 in 2011 to 56.5 in this year s ranking. The improvement has been broad based, with gains dispersed across Environmental, Social and Governance indicators. Controversies: The industry has been involved in fewer controversies in recent years. Of the 149 insurance companies in our research universe, none is currently facing exposure to a severe (Category 4 or 5) controversy. A total of 181 Category 1 to 3 controversies have been recorded, the majority of which affect Customers and Society & Community and involve anti-competitive business practices and the social impact of insurance products. Geographic composition: Most insurers in our research universe are based in Europe (55) and North America (45), with the remainder distributed across the Asia-Pacific (28), Latin America (12) and the rest of the world (9). With an average score of 62, European insurers stand out as top global performers. The mean score of insurers in other regions ranges from 51 (Latin America) to 56 (Rest of World). Size effect: We find a moderately positive correlation (0.28) between market cap and overall score, which likely reflects the larger pool of resources available to larger firms when building sustainability programmes and strategies. While the largest company in our universe by market cap, Allianz, is also the top overall ranked insurer, company size is by no means a perfect predictor of ESG performance. 1 Update financial and ESG data: April 2015 6 P a g e